Childcare is an ever-increasing expense for many families, especially in households with a single parent or where both parents work. Everyone wants the best possible care for their children, and that often comes with a high price tag.

Recently, a new tax law made the funds in 529 Plans available for early childhood education expenses, not just college. As we’ve written, it is wise to consider all options before deciding to use 529 funds before your child is in college, at least if you want to take full advantage of the savings. But, if you want to use pre-tax dollars to pay for dependent-care expenses, maybe a Flexible Spending Account, or FSA, is the way to go.

WHO QUALIFIES FOR AN FSA?

An FSA covers qualified dependent care expenses. Qualified dependents are children in your home age 13 or younger that you claim as dependents on your taxes. Also, a disabled spouse or adult(s) who live in your home at least 8 hours a day, are incapable of caring for themselves, and are claimed as dependents on your taxes can qualify. This does not apply to elderly parents or grandparents in nursing homes or assisted living centers.

In order to qualify, you must either be single, or you and your spouse must both work, be looking for work, or claim disability. The earned-income requirement is waived if you or your spouse is a full-time student.

WHAT EXPENSES ARE COVERED BY AN FSA?

While not every expense qualifies for FSA coverage, many do. Dependent Care FSA’s can cover costs associated with the physical care of a child or adult such as a nanny or in-home nurse. It can cover costs of daycare services for children or adults, as well as summer day camp expenses. Before- and after-school care - including transportation expenses - can be covered by your FSA.

The catch, though, is that FSA’s only cover costs up to $5,000 for married couples filing jointly and those who are single. Married filing separately is limited to $2,500 per spouse. So, while a wide range of costs qualify for coverage, that doesn’t mean you’ll be reimbursed for everything you spend.

When it comes to those reimbursements, the IRS decides what it will and will not cover. A good rule of thumb, though, is that any cost associated with the care of qualified dependents so you can work will most likely be covered by an FSA.

HOW DOES AN FSA WORK?

FSA’s are employer-based, like a 401(k). You tell your employer how much to withhold from each check which is then deposited into your FSA. They also work on a reimbursement system, so you pay all your fees and expenses up front and then get reimbursed through your FSA. It is critical that you save all receipts associated with the services for which you want to be reimbursed. Most of the time, the IRS will require the original receipt with the amount paid (credit card statements, canceled checks, or copies of a bank statement are usually not accepted as receipts), the date of the service provided, and the social security number or tax ID of the service provider.

Unlike a 529 plan or 401(k), FSA contributions do not accrue over time. You are given a limit of $5,000 each year, and you either use it or lose it. Most unused FSA contributions are returned to the employer.

So, while an FSA won’t cover every expense associated with childcare, it can certainly help. And, because they’re pre-tax, FSA contributions lower the amount of taxable income you claim each year. If you are interested in speaking to one of our advisor’s about setting up an FSA, click the button below.

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